An emergency fund is important if you wish to stay off the debt treadmill. It happens to everybody. You hit that point where you decide you are going to turn your life around. You meticulously develop a budget and work to pay off your debts. Finally, you reach that point where you make your last payment. Just as you are going to breathe a sigh of relief, disaster strikes. Maybe your car breaks down, or you get sick. In any case, you are forced to tap into credit to cover the expenses and climb back onto the debt treadmill.
The solution to avoiding that scenario is to have an emergency fund built up. An emergency fund is a set amount of cash that you have tucked away in a very liquid and accessible account. There are varying opinions as to how much is the right amount to have tucked away into one. Conventional wisdom says you should have 3-6 months of expenses tucked away. David Ramsey believes you should aim for $1000 and focus your extra money on paying off debt. For those who might be financially independent, the recommendation might jump to 1-2 years worth of expenses so you can ride out bad market years. However much you put away is going to depend on your own comfort level and personal situation.
My own emergency fund structure
My own personal emergency fund threshold is $2000. It is well short of 3 months worth of expenses and I honestly don’t think it would be enough to last 1 month. Why would I put myself at risk and keep it so low? I do this because I would rather put the money towards my student loans. $2000 will be enough to cover things like unexpected car trouble, and should things become apocalyptic, there is always my Roth IRA*.
The other reason I keep it low is because I know myself. I could go and save up 3 – 6 months worth of expenses. The moment my student loan debt became lower, I would be extremely tempted to drain the account and wipe out my student debt. My justification would be that I could quickly build the emergency fund back up with my the funds I was using to pay off my loans. This would be accurate but in this scenario I would pay more in interest than if I just had the $2000 emergency fund and paid more debt down sooner.
An emergency fund at work
I actually had a problem not too long ago that led to me having to tap into my emergency fund. I was on my way home from work when the warning light came on for low air pressure. Not a big deal, I pulled over into a gas station parking lot and filled up my tires. *Quick aside. A 12 volt powered air compressor is a great tool to keep in your car. It can be stored in the car easily and can easily help you out if you ever find yourself with a flat tire* I wrote off the problem and drove home.
The next morning though, the light came back on. Turns out one of my tires had a small leak. Also saw that my front tires were well past replacement tires. A simple patch wasn’t going to cut it, the tires would need to be replaced. I was hoping to wait until after the move when my money situation would be more routine, but luck was not with me. I can’t complain too much because they were the tires I got when I bought the car so who knows how old they were before. I got over 3 years use out of them.
I did want to quick ask a question of you guys. When I got the tires changed, I went ahead and got an alignment done as well. The car had no issues driving straight but my thought was if I am going to spend $250+ on tires, might as well make sure they wear down evenly. Do you get an alignment done only when needed or do you get them done with tire changes as well?
Back to the story, paying was an interesting experience. The man ringing me up kept asking if I wanted to get their company credit card. It came with 0% interest for 6 months and was great for situations like these, blah, blah, blah. I thought to myself how many people get trapped into ringing it up on a card because they don’t have the money. They put off payments because there is not interest for the first few months. The promotion rate expires and they are stuck in a deeper hole because of a problem they had several months ago.
With money on hand, I could avoid using their carefully laid trap. I still put it on a credit card because cash back bonuses are a wonderful thing. $4.00 back isn’t much but every little I get back is money I can put towards my student loans.
Do you have an emergency fund? What is your threshold amount: $1000, X number of months expenses, something else? Leave your thoughts below and thanks for reading.
*I realize some people would cringe at the idea of tapping into a retirement fund. I’m not crazy about the idea either, but if push came to shove, I would do what is needed to provide for myself and my loved ones. I don’t plan on that happening though. If I can come out of college and get a job in the middle of the worst recession we’ve had in almost a century. I think I can manage now that I have experience under my belt.